Is Dollar Cost Averaging A Winning Strategy?

The press often writes about the advantages of dollar cost averaging. The main idea is that people spread out investing over a period of weeks or months, instead of placing a large sum of money in the market at once. In other words, if the market goes down, people’s next investment will be completed at lower prices.

Unfortunately, research suggests investing a large sum of money at once (as opposed to dollar cost averaging) actually produces better investment results. For example, a study by the Vanguard fund group, found that for the U.S., Australian, and U.K. markets a lump sum investment produced a higher total return than dollar cost average investing 67% of the time. This seems logical since markets deliver positive returns far more often than negative returns.

A different study from Seeking Alpha, found that during the past 27 years, the average lump-sum 12-month return in the S&P 500 was 8.77%, while the average dollar-cost averaging return would have been 4.77%. The returns of dollar-cost averaging strategy came a little closer to the lump sum strategy when bonds were substituted for cash.

Dollar cost averaging has shown some advantages – it reduces the risk of investing at the “wrong” time. For example, another study suggested the lump sum drawdown was 9.98%, but only 5.87% for the dollar-cost averaging strategy.

There is a calculator that allows you to compare results between lump sum vs. dollar cost averaging. You can select the year and month of the lump sum investment and compare the result to investing equal monthly amounts throughout the entire year. If you are interested, go to www.moneychimp.com/features/dollar_cost.htm